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How to balance essential spending and saving for your family

Published: February 2013

With the age of the company pension mostly behind us, the vast majority of Americans are not saving enough for a comfortable retirement—or saving much at all. College (heck, even preschool) costs keep skyrocketing, and if you’re still paying off your own student loans, your child’s college fund may end up on the back burner. And what about having some savings ready so that you don’t go into credit-card debt if your refrigerator or car dies?

If you have those concerns, you’re not alone. Carolina, an East Coast mom of two toddlers, says, “My concerns are usually that I’m not doing enough—that the cost of living is always getting higher and that whatever I am planning for today will not be enough for the future, because of inflation.”

Yes, it’s a balancing act, but you are used to that from being a parent, right? And we’re here with the advice you need to succeed. The key is to start now. To meet the challenge you’ll need a three-pronged attack:

Second, make sure you are minimizing your tax bill by taking advantage of every parent-friendly exemption, credit, and flexible spending program available to you. And of course, parents should update their withholdings to maximize their take-home pay.

Third, create a budget that allows for not only the essentials but also an emergency fund, retirement investments, college savings for your kids—and last, funds for fun stuff your family loves to do. Read on for lots of advice to help you do just that.

Your basic living expenses, including mortgage or rent, utilities, insurance, food, and clothing, should equal no more than about 60 percent of your income. The remaining 40 percent should be for discretionary spending, savings, retirement, and investing.

Should you own or rent your home?

It depends upon your current situation, according to Eric Tyson, author of Personal Finance for Dummies (Wiley). “If you don't see yourself staying put for at least three to five years, you're generally better off renting given the significant transaction costs of buying and then selling a home,” he explains. But over the long haul, owning is advisable because you build equity, and as a renter, your housing expense is exposed to inflation.

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Budgeting for now and the future

Saving for the future is important because it will help you purchase the essentials for survival if and when you no longer have an income (or an extra cushion to make up for any gaps in Social Security or a pension—if you have one). The trick to successful saving is to make it a routine part of your life.

Larry L. and his wife (who have an 11-year-old son) have done just that. “We do put money away for retirement and our son’s education,” he says. “It’s really a non-issue. It’s like a prepayment to those things.”

If you don’t have your savings on auto-pilot just yet, don’t despair. It’s as simple as writing down what you’re bringing in, where that money is currently going, and what you have left to save. “The key,” says Tyson, “is to analyze 6 to 12 months of your spending and identify where you can cut” so that you have more to save each paycheck.

How much should you be saving, overall? According to Tyson, “It depends upon your goals and current financial situation. Generally, you should try to start saving 5 percent of your gross income and then get up to at least 10 percent.”

The savings goal that makes sense for your family depends on factors such as your job security, your health and the quality of your health-care coverage, the number of wage earners in your household, how many dependent children you have, your access to emergency sources of credit (including home-equity lines), and the likelihood you'll need to make major purchases or repairs.

If you’ve already started saving and you want to avoid the temptation of spending that money, create a separate capital fund for big-ticket expenses you expect within the next five years, such as a new car, a major vacation, or a down payment on a house. That will also protect you from the trap of creating high-interest credit-card balances when big-ticket needs arise.

Regardless of your savings goals, even if you can set aside only a few dollars a week, have it go direct-deposit from your paycheck before you even see it. Soon you'll adjust to not having that money, and you might find it easier to increase the amount gradually without causing real pain. If you get a raise, don’t spend it—funnel it into paying off debt and savings. Learn more about the safest places for your cash.

Log spending

The best way to save is to learn more about where you spend.

Record your income and expenses on a monthly basis with pen and paper, spreadsheet, personal-finance program, or online budget calculator. (Most programs and sites can automatically gather spending data from the websites of your bank and credit-card companies if you want, and let you mark each item with a tag that categorizes its purpose, such as "clothing," "dining out," or "auto repairs.") Use whatever system works for you.

If you have bills that come regularly but are not monthly—a semi-annual car insurance payment or a property tax bill for example—divide those bills into monthly chunks for the purpose of creating your monthly budget. Log small cash purchases in your smart phone or notebook as they occur. Do that exercise of recording all your expenses for several months so that you'll be more likely to capture large unforeseen but unavoidable expenses, such as a major car or home repair.

Once you see how much you’re spending on everything, try to find ways to cut down your expenses in every area, such as your weekly food bill (see our store brand vs. name-brand face-off). When you’ve cut as much as you can (and you should reassess expenses, whether it's a calling plan or dining out, on a routine basis), start saving for emergencies, retirement, and college for your kids. You can start by trying to trim your expenses by 10 percent per month, and build from there.

Tackle debt

Before you start saving, pay off your debt.

“Paying off consumer debt should be your number one priority,” Tyson says. “The interest rates tend to be high and provide no tax benefits. And it can continue growing, and handicap your ability to accomplish your future financial goals,” he adds. It’s a no-brainer if you think about it: What’s the point in putting money in a savings account that these days pays less than 1 percent, while shelling out 14 percent on a credit-card balance? Learn more about how to pay down your debt. And, worst-case scenario, should you find yourself without enough money to pay off a major expense, you can get a cash advance on a credit card with a low or no balance.

Fund emergency savings next

With every natural disaster, news photos of ruined homes and destroyed possessions put into stark reality the need for a family savings plan, along with appropriate insurance. “The recent storms are a good example of why you should have an emergency fund,” says Tyson. It’s essential to build up a cushion of cash to protect you and your family in case of emergencies like this one, or others such as job loss or medical bills. Even a major veterinary bill can set you back.

If you want to start those college and retirement accounts, you certainly can, but according to Tyson, “Folks should generally save for an emergency fund first.” And what if disaster really does strike? “If there is an emergency and you deplete the fund,” Tyson adds, “you should stop funding retirement accounts to replenish them.”

How much of a safety net do you need? Aim for a “minimum of three months’ worth of living expenses in liquid accounts (checking, savings, or money-market fund),” suggests Tyson. But, he adds, “If you have an unstable job situation or work income, consider keeping six to as much as 12 months’ worth of expenses.” (For more information on where to keep your money, read about the safest places for your cash.)

Retirement savings is next

After you’ve saved an emergency fund, “then tackle saving for retirement,” suggests Tyson. “Saving for retirement should come ahead of college savings because money in retirement accounts is not considered an asset for college funding.” And you (and your children) can always borrow to pay for college, but not for retirement.

For most people, money for retirement should go into a tax-advantaged retirement account. Join your company's 401(k) or 403(b) plan, if it has one, and set aside at least as much money as the company will match and more if you can handle it. In this economic environment, it may be hard to consider maxing out on your retirement-plan contributions at work. But if you put aside enough each pay period to qualify for your employer's match, you'll be doing yourself a favor twice over. For one, that match is like an automatic pay raise. If your employer matches 50 cents on the dollar, then setting aside 6 percent on a salary of $60,000 earns you an extra 3 percent—or $1,800—a year. Your savings on income tax also could be significant, because the money you set aside for your retirement account is subtracted from your gross taxable income.

Whatever retirement vehicle you choose, make sure you’re investing through direct deposit so that you can make sure you’re automatically putting money aside before you even see it. (See more advice about retirement-plan contributions.)

As long as your financial portfolio is diversified, your investments are probably going to be in good shape over the long term no matter which way the economy goes. You’ll find the most diversification through broad-based mutual funds, particularly those that track market indexes such as the Standard & Poor’s (S&P) 500. Always look for the lowest-cost mutual funds, or exchange-traded funds (EFTs)—mutual funds traded as stocks—as reflected in their “expense ratios.” Research by the investment research company Morningstar shows that the best indicator of a fund’s performance is its cost, and funds with lower expense ratios do better over time. You can find index mutual funds and ETFs tracking the S&P 500 with expense ratios less than $10 per $1,000 invested.

More saving tips

Keep a tight grip on your credit cards.Credit cards can offer advantages, including awards, cash back, and extra warranties and other protections, but only if you have good spending and budgeting habits and the discipline to pay your balances in full each month. The problem is that credit cards can also make it too easy to buy things we don’t need and spend too much on the things we do need. If you find yourself building credit-card debt, credit counselors recommend that you leave your cards at home when you go shopping and pay cash or use a debit card instead.
Dine out with cash, too. Using a credit or debit card at restaurants can encourage you not only to overspend but also to overeat. People who put their meals on plastic usually spend about 30 percent more than those who pay cash.

Rethink automatic expenses. Having money taken automatically from your bank account or charged to your credit card each month for services such as subscriptions, DVD rentals, fitness-club memberships, or season tickets to the local basketball team can be a time-saver but also a money-waster if you don't use what you're paying for. Go down the list of such expenses and ask yourself whether you still have time to use those services now that you're a parent. If not, call and cancel. (You can always sign up again later.)

Size up expenses routinely. Review your bills—everything from cable to cell-phone service to gym memberships—on a regular basis to see whether you can get a better deal or cut them out completely.